New Zealand proposes sweeping emissions trading reforms

On 13 August 2018, the New Zealand Government released a consultation document proposing a range of reforms to improve the New Zealand Emissions Trading System (NZ ETS). Specifically, the government proposes to: coordinate decision making on supply settings, introduce auctioning, develop a new price ceiling, limit international units and phase down free allocation for industry. The proposed reforms follow from the second NZ ETS review process, which concluded in mid-2017. While some reforms, such as the phase-out of the 1-for-2 compliance measure, have already been implemented, several in-principle decisions were taken in 2017 to adjust the framework legislation of the NZ ETS in order to make it fit-for-purpose to help New Zealand deliver on its 2030 emissions reduction targets. The new proposals would implement these in-principle decisions, as well as taking steps towards reducing industrial allocation. Together, the proposed reforms would enable the government to effectively cap emissions from covered sectors and manage this cap in a coordinated, transparent and predictable way.

Coordinated decision making on supply settings

The government proposes to set a limit on the number of New Zealand Units (NZUs) that can be released to the NZ ETS market each year. The overall NZU limit would be announced annually for a rolling five-year period, such that in each year participants have a 5-year outlook. While future supply volumes may still be adjusted after they are announced, the volumes become fixed one year in advance. This measure is designed to increase the transparency of unit supply decisions and give all participants greater certainty over market developments, while aligning the unit supply in the NZ ETS with New Zealand’s economy-wide emissions reduction targets and carbon budgets. Decisions on the supply of allowances would take into account all relevant market information, including allowance quantities from auctioning, free allocation, international units and a new cost containment reserve, as well as projected removals from the forestry sector.

An auctioning mechanism

As a central tool for managing supply, the government proposes to auction a share of allowances. This could be done either monthly or quarterly with a single round, sealed bid, uniform price format. The auction quantities would be set as part of the coordinated decision-making process on supply. Decisions are still to be made on whether auctioning revenues should be earmarked for a specific purpose.

Reforming the price ceiling

The government proposes to implement a cost containment reserve (CCR) to replace the current NZD 25 fixed price option that functions as a price ceiling. Under the CCR, NZUs from the reserve would be released for auctioning once a ‘trigger price’ was reached. Both the trigger price and the reserve quantity would be decided as part of the coordinated decision-making process on supply, and it is likely that the price ceiling would be higher than the current fixed price option. The specific settings for the CCR would also be subject to public consultation at a later date. While the fixed price option would remain in place until 2020, it may be adjusted before then - the current price is already close to this level, and the extensive use of the fixed price option could lead to the supply of NZUs exceeding the 2030 carbon budget.

International units

The government proposes to limit the quantity of international units that may be used for compliance in the future. The NZ ETS may re-open to international carbon markets after 2020 if imported units are genuine and have environmental integrity, if progress towards mitigation targets and incentives for domestic abatement are maintained, and if it makes economic sense to do so. Two elements would be regulated: (a) the mode of purchase, i.e. whether market participants have direct access to purchasing, trading and surrendering international credits, and/or indirect access via government-controlled purchase and auctioning; and (b) limits on the number of units that can be surrendered by NZ ETS participants, as a percentage of surrender obligations. Both these elements would be managed through the coordinated decision-making process on supply. The government is also considering whether the international offset limits should vary depending on the type of market participant.

Industrial allocation phase down

The government is seeking feedback on when and how to reduce the share of allowances freely allocated to emissions intensive and trade exposed (EITE) industries. Currently, the government is considering a one to three percent annual reduction of the share of free allocation starting from 2021.

The consultation document also proposes further measures to improve market governance and information availability, as well as reforms to compliance and penalties. In order to support informed decision making by participants, the Government has recently launched a dedicated NZ ETS website to provide easy access to information on the carbon market.

Alongside the NZ ETS design reforms, several changes have also been proposed for the forestry sector. One of the first sectors to be covered by the NZ ETS, the forestry sector has great potential to sequester carbon dioxide and is a major source of NZUs from removal activities. A separate discussion document for public consultation sets out specific government proposals for the sector. Proposed changes include: moving to an ‘averaging’ accounting approach; recognizing emissions reductions from harvested wood products; introducing a permanent forest category in the NZ ETS (currently under separate legislation); and improving technical and operational procedures.

So far, the main proposals for NZ ETS reform focus on fundamental design elements that require legislative changes. Public consultation on the proposals ends on 21 September 2018. The legislative process is then set to begin by the end of 2018 in order for such changes to be integrated into law by 2019. Consultation on specific regulatory settings, such as the number of allowances to be auctioned, is then planned for 2019, so that the overall policy reforms can be implemented in 2020.

The current proposals do not yet consider the role of agriculture in the NZ ETS. The independent Climate Change Commission will be tasked with considering whether and how agricultural emissions should enter the NZ ETS, with recommendations expected in 2019.